Financial services is a funny industry. It is an industry where the participants somehow decide that they are smarter than the great thinkers - the Nobel prize winners - in financial economics.
Merton Miller (Nobel prize winner) explained why the expected return of an investment has to be linked to risk; why there are no free lunches. And yet many people in the industry still promote low risk ways of earning a high return. They simply don't exist, people are too selfish to give away a return higher than they need to - so the return will always be related to the risk.
William (Bill) Sharpe (Nobel prize winner) explained that they best way to earn a return above the cash rate was to expose some percentage of your portfolio to the sharemarket, in a broad and diversified way. The sharemarket provided a 'market risk premium', that is a higher rate of return over the long term for people who invested in it.
Markowitz (Nobel prize winner - do you notice any pattern?) said that an investor should use diversification to minimise the amount of volatility (ups and downs) in their portfolio, to try and get a smoother return over time.
So there you have it. The fundamentals of investment success from some of the great thinkers:
- If you want a higher return than a cash investment, expose some of your wealth to higher risk, higher return sharemarket investments.
- Don't look for shortcuts - risk and return are related, so high return must mean high risk.
- Diversification is an investors friend - use it to minimise the ups and downs of your portfolio.